FINANCIAL INNOVATION AND MONEY DEMAND - APPLICATION TO CHILE AND MEXICO

This paper re-examines the estimation of money demand equations using quarterly data for Chile and Mexico. We find no evidence of cointegrat ion of traditional long-run money demand equations. In light of this e vidence, we argue that there is an important permanent component of th e demand for money not captured by traditional variables (interest rat es and income). We call this phenomenon financial innovation and we in clude it in the traditional specification by assuming that it follows a random walk.